Chesapeake: Keep Calm And Carry On

Summary

Chesapeake tries to calm investors by stating it doesn't plan to pursue bankruptcy.

Nonetheless, Chesapeake's stock remains below $2.

Does the company face a liquidity problem that could force CHK to file for bankruptcy anytime soon?

In an attempt to calm the market, Chesapeake Energy (NYSE:CHK) issued a statement that it isn't perusing bankruptcy procedures at this point; the oil and gas producer aims to restructure its balance sheet, considering it has more than $10 billion in debt even after the latest debt exchange. Analysts who favor CHK quote its liquidity and low valuation, while those who think this company isn't the right oil play quote the still hefty debt and higher chance of a bankruptcy over the next year. Given the current market sentiment about oil in general and U.S. oil shale companies in particular it seems unlikely the stock will recover any time soon. And at $30 a barrel, the company isn't breaking even - this makes it harder for the company to stay afloat.

Break-even point

Based on the company's own calculations, the breakeven point for its major oil projects (PV-10) is around $45, while for the natural gas the breakeven point is close to $2.5. Since the price of oil is trading at $30 and natural gas at $2 this means the company's output isn't reaching this breakeven point. CHK has hedges on 55% of its oil yield and a third of its natural gas production for 2016, which should bring up the realized prices a bit. But after considering transportation costs and discounts, realized prices are likely to be, when it comes to oil, not far off market price; realized prices of natural gas are likely to remain below market prices. Even after eliminating the dividend on common share back in July 2015 and preferred stock earlier this year - two moves that would free up roughly $410 million per annum - CHK may have to take on more debt to finance its operations including its capital spending. But for now, the company does seem to have enough funds to stay above water.

On liquidity and maturity

Following the last debt exchange, the company was able to improve its stance in two ways: By reducing its debt by around $1.5 billion to a total debt load of nearly $10 billion; and by raising the maturity so that the company will have repay back its debt holders less in the next few years. And since it still has more than $1.7 billion (as of the end of September) along with an untapped $4 billion in revolving credit facility, CHK isn't likely to face a liquidity problem in the near term. But this could change in the coming months. After all, this credit facility, even though it is a secured loan with liens on assets, it also comes with restrictions including the amount of junior lien debt CHK can incur - for now, up to $2 billion. If CHK plans to restructure its debt, such restrictions could make it harder on CHK. And the credit facility could be reevaluated and reduced in April. Thus, if the credit facility is reduced or even eliminated, it could put CHK at a much more precarious situation.

But for now, if the company were to file for bankruptcy, it would be due to a balance sheet insolvency. Considering oil and natural gas prices fell in the last quarter of 2015, the company is likely to record another impairment provision that will cut down its equity - as of Q3 equity stood at $4.2 billion. This will only raise CHK's debt burden and the chances of some debt holders - especially holders of secured debt -- to consider forcing the company to go bankrupt.

This is why the company plans to cut its debt burden by either selling assets or restructuring debt or both. Some have already pointed out that the company may be consider selling its Utica assets, which will bring in $2 billion. But it's also worth noting that the company has already sold a big chuck of its assets in recent years after it faced a debt problem a few years back. According to Bloomberg, CHK sold assets for a total of $16.2 billion in 2012-2014. Those assets, however, were sold when the oil market was heating up with oil prices around $90+ a barrel and natural gas ranging between $3.5 and $4.5. Selling additional assets at these times will be a much harder task and even so it will be at discount prices.

In conclusion…

The company doesn't plan to start bankruptcy proceedings, but it will be harder to ward off its debt holders given the current state of its balance sheet. Chesapeake doesn't seem to have a liquidity problem for now, but this could change - mainly if the revolving credit facility is reduced. The next earnings report will show what the company plans to do in terms of capex, production and assets. Also the restructuring of the balance sheet will keep weighing on the stock. So while the company may not be heading towards bankruptcy courts anytime soon, its current situation isn't encouraging.

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.